COLUMNS

Down in the Valley

Donald Coxe May 20 2002
COLUMNS

Down in the Valley

Donald Coxe May 20 2002

Down in the Valley

Donald Coxe

How do you tell audiences in San Francisco that the oudook for technology stocks is even worse than it was in 2000 or 2001?

That’s the challenge I have been facing in speeches to audiences in the Bay Area. What they want to hear is encouragement that the worst is behind them and that brighter days are coming, along with the brighter outlook for the global economy. I tell them that not even a runaway economy will drag Silicon Valley’s companies back to stock market stardom. Like oil and gold stocks after the bursting of the inflation bubble in the 1980s, tech and telecom have years of anguish ahead.

The villain? It’s called the free market. Markets are moved by people, and people have fads and fancies that wax and wane. They understand that principle of psychology down the coast in Hollywood, where no film production company stays on top for long. The difference is the length of the cycles: Sony is back on top with Spider-Man, after four bleak years following its box office triumphs with Jerry Maguire, Air Force One and Men in Black.

Hollywood’s excesses are legendary, but other industries that get carried away with their own press clippings can make Tinseltown look as modest as the Amish. The gold and oil producers believed they could keep expanding their output because the world would keep paying up big for inflation hedges. When Paul Volcker, Ronald Reagan and Margaret Thatcher crushed inflation with sound monetary and economic policies, those stock groups entered bear markets that ended only recently. Capitalism is Calvinism in action, but people get punished for their sins of Pride and Greed here on earth.

I tell my audiences of the irony that a big reason for buying oil, base metal and gold stocks is the reviving economies of East Asia, particularly China. That boom is being led by tech industries there, which will ensure that Silicon Valley’s problems of overproduction continue. China has circumvented U.S. export controls on manufacture of next-generation chips, buying the needed equipment from the Germans and Japanese. That means its own tech industries will move rapidly into global competitive stature, just as its computer industry has done in the past two years. The richer East Asia gets, the more it needs to import basic materials. So the Valley’s pain is Canada’s gain. I note that, while Nasdaq keeps fulfilling its leadership role as U.S. stocks slump, oil and gold companies appear on Wall Street’s new-high listings.

Audiences seem most uncomfortable when I refer to the problems facing tech companies if they are forced to account

It’s tough to tell Bay Area techies the outlook for their stocks is still grim. And as for their house prices...

for the stock options they distribute so promiscuously. They have been getting away with showing them at zero cost in their earnings reports. As the New York Times has reported, even when Dell Computers lost more than US$1.2 billion in the markets trying to hedge the cost of its stock options, the company did not report that loss—which roughly equalled its total earnings. (Dell had to cover so-called put options it issued to reduce its cash expenditures for buying back stock distributed under stock options. A put option is a publicly traded guarantee to buy a stock at a fixed price for a stated time. If the stock falls sharply, the issuer of the options is on the hook big time. For years, Dell made tons of money doing this, because its stock always went up, so those puts expired worthless and Dell pocketed the premiums. Now that Dell has joined lesser tech companies on the losers list, it’s having to pay up.)

No less a savant than Alan Greenspan says that such misleading reporting has led to massive misallocations of capital (read: grossly overpriced tech stocks that grossly overinvested in producing tech hardware). He says that during the 1990s, fully 2.5 percentage points of the annual 8.5 per cent gain in reported profits on the Standard & Poor’s 500 came from companies’ failure to show the costs of their options. (Tech companies were the worst offenders, but stock optionitis proved to be a highly communicable disease during the 1990s; fortunately, like Enronitis, it can be cured.)

One bit of good news I give them is my assertion that the U.S. dollar has entered a bear market against leading foreign currencies. That should help keep more U.S. tech plants open during the coming long years of global gizmo oversupply.

Many of the audiences’ questions relate to the war on terrorism. In part, these concerns arise because of the publicity given to Warren Buffett’s comments on the probability of “nuclear events” in the U.S. Although Californians are renowned for their laid-back attitudes, tech plants there have introduced elaborate security precautions. One investor said, “I’m glad to be living here, and not in New York or Washington” (the cities Buffett mentioned as prime terrorist targets).

I am told that Valley house prices have held up surprisingly well, despite the carnage on Nasdaq. I have declined to make a forecast about the continuation of that good news if my predictions for further tech stock plunges are validated; I like to shake hands with people in the audience after the speech ends. ES]

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments.